Guaranteed income in retirement
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A common fear among retirees and soon-to-be retirees is running out of money. And as we now know, social security is not designed to be a retiree’s only source of income. Let’s explore another avenue for creating guaranteed retirement income.
The Certainty of Uncertainty
Most of us will supplement social security with 401k, IRA, Roth IRA, or brokerage account payouts. Relying on a portfolio for income introduces a host of uncertainties via the nature of markets and investing. You can reduce uncertainty by building a diversified portfolio and having a margin of safety, though uncertainty will always be present.
However, there are ways to reduce that uncertainty. A change included in Secure Act 2.0 made one particular strategy more appealing by increasing to $200,000 the amount that individuals can invest in qualified longevity annuity contracts (QLACs) through their IRA or 401k accounts.
The Mechanics
In purchasing a QLAC, you are giving money today to an insurance company in exchange for receiving a set annual payout starting in the future. The start date is determined at the time of purchase but can be no later than age 85. The longer you wait before taking payouts, the higher those payouts will be. Payouts can also be either single or joint life, i.e., they can pay based on one person’s life or until both spouses pass away.
Joint life can provide additional peace of mind, but the payouts are generally lower. Buyers can also opt for a death benefit, guaranteeing that heirs will get the original investment back (less any payouts already made) if you pass early.
Fidelity has an online tool that gives rough estimates of what to expect. For a couple who are both 70 years old, buying a $200,000 joint life QLAC today would provide about $19,000 in annual income starting at age 75. Pushing the start date back to age 80 bumps the annual payment to a little over $29,000, while waiting until age 85 means a $48,500 annual payment.
Potential Benefits
Money that goes into a QLAC is no longer counted for Required Minimum Distribution (RMD) calculations. For example, if you invest $200,000 from a $1,000,000 IRA into a QLAC, your RMD would only be based on the remaining $800,000 in the account. That can be attractive for individuals who may only need their portion of RMD in their early retirement years. Reducing RMDs also reduces the income that counts towards Medicare premiums.
QLACs are Medicaid compliant, meaning that until they begin paying out, they are not considered an available resource for Medicaid eligibility.
A QLAC potentially moves money out of your estate, assuming no death benefit is chosen or once payouts exceed the premium.
Some Drawbacks
The purchase of a QLAC is irrevocable. If you suddenly have an emergency and need money before the payments are scheduled to begin, you are out of luck. The terms are locked in at purchase.
You also may see the purchasing power of your payout erode over time due to inflation. If inflation runs hotter than expected for several years, that future payout may not go as far as you thought.
The total payouts received depend on how long you (and potentially your spouse) live. You can mitigate that via a death benefit, which will lower your annual payout.
Note that payouts from a QLAC do count as taxable income. While you delay the tax impact when buying a QLAC, you can’t avoid it completely.
Summary
QLACs are not appropriate or necessary for everyone. But they may be an attractive option if you face the real threat of outliving your money. Just ensure you know what you are getting into and talk to a professional before making the leap.
David Crossman, CFA, is a Senior Portfolio Manager with Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.bedelfinancial.com or email David at dcrossman@bedelfinancial.com.